Accounts Receivable - AR

What are 'Accounts Receivable - AR'

Accounts receivable refers to the outstanding invoices a company has or the money the company is owed from its clients. The phrase refers to accounts a business has a right to receive because it has delivered a product or service. Receivables essentially represent a line of credit extended by a company and due within a relatively short time period, ranging from a few days to a year.

BREAKING DOWN 'Accounts Receivable - AR'

On a public company's balance sheet, accounts receivable is often recorded as an asset, because there is a legal obligation for the customer to remit cash for the debt. If a company has receivables, this means it has made a sale but has yet to collect the money from the purchaser. Essentially, the company has accepted an IOU from its client.

Why Do Businesses Have Accounts Receivable?

Most companies operate by allowing some portion of their sales to be on credit. In some cases, business offer this type of credit to frequent or special customers who are invoiced periodically. The practice allows customers to avoid the hassle of physically making payments as each transaction occurs. In other cases, businesses routinely offer all of their clients the ability to pay after receiving the service. For example, electric companies typically bill their clients after the clients have received the electricity. While the electricity company waits for its customers to pay their bills, the unpaid invoices are considered accounts receivable.

What Happens When a Company Cannot Collect Its Accounts Receivable?

If a company cannot collect its accounts receivable, it may decide to take the debtor to court over the unpaid debt, or it may outsource the debt collection activity to a third-party bill collector. These companies typically charge a set fee or a percentage of the amount they collect. In other cases, businesses sell their accounts receivable for pennies on the dollar to a factoring company that then collects the debt. Factoring companies often offer some cash up front, making them an attractive option for companies that need a boost to their working capital.

If a business has reported an account receivable as income and it does not receive payment, it has a bad debt. The Internal Revenue Service (IRS) allows businesses to subtract bad debts from their gross income on their income tax returns, as long as they reported the debt as income on a previous return.

Difference Between Accounts Receivables and Accounts Payable

When a company owes debts to its suppliers or other parties, these are known as accounts payable. Accounts payable are the opposite of accounts receivable. To illustrate, imagine company A cleans company B's carpets and sends a bill for the services. Company B owes the money, so it records the invoice in its accounts payable column. Company A is waiting to receive the money, so it records the bill in its accounts receivable column.